Mal Maiden dissects Julia Gillard’s new mining tax. What does it mean for business and who is going to pay?

Is this a massive backflip by the government or a brilliant piece of re-engineering that sets Julia Gillard up for an early election? Both.

The new Minerals Resource Rent Tax is almost unrecognisable from the Resources Super Profits Tax it replaces.

Instead of being applied across the entire resources sector, it focuses on only two mining businesses, iron ore and coal, with the existing Petroleum Resources Rent Tax extending to the domestic oil and gas industry, including the fledgling coal seam gas projects in Queensland.

Instead of being an elaborate scheme that sees the government take 40 per cent of mining profits but also assume 40 per cent of the development costs and risk on each project, it simply taxes the miners at the mine gate, for 75 per cent of their income at that point, at a rate of 30 per cent.

This concession, that the miners pay only 30 per cent of 75 per cent of their income at the mine gate after costs to that point are deducted means that the real new resources rent tax rate is about 22.5 per cent, not 30 per cent as advertised.

Instead of forcing the big miners into a resources tax regime with the big mines still valued at book value, a fraction of their real worth, it gives them a choice (it’s complicated, but here goes): either bring their existing mines into the scheme at book value, in which case they will be able to aggressively create depreciation tax deduction over just five years, and will not be liable for the 30 per cent resources tax until their mine returns have exceeded the 10-year Commonwealth bond rate plus 7 per cent (about 12 per cent currently), or bring the mines in at market value (defined as cash flow plus the risk value of the resource) but write the value down in smaller increments over a longer period, up to 25 years, and have the tax imposed without a hurdle rate. It’s likely that the big miners will opt to inject their assets in at market value. In either case, they can claim what they invest in their mines as they go.

Inspired move

And instead of applying to all mines, the tax also exempts iron ore and coal miners with profits of less than $50 million. This is an inspired idea, and like the proposal to limit the scope of the tax and exclude not just quarries and other low value operations but copper, nickel, gold and bauxite mines it came from the big three miners who were negotiating the deal, BHP Billiton, Rio Tinto and Xstrata.

These two measures see the number of companies affected by the new tax fall from about 2500 under the original proposal to about 320, significantly reducing the risk that the deal will be seen as one cooked up by the big three miners for the big three miners.

The existing 40 per cent Petroleum Resources Rent Tax is also being extended, to cover not just offshore projects but the entire Australian oil and gas industry, including the merging coal seam gas producers and exporters in northern Queensland, and the oil and gas groups will also be able to elect to inject their assets at market value, and expense their development costs as they go.

Gillard makes the call

So if radical change to the original proposal qualifies as a backflip, this certainly is one. But it’s a backflip from a tax proposal that was launched and prosecuted by Kevin Rudd, not Julia Gillard. Treasurer Wayne Swan was involved in the talks this week, but the key figures were Gillard, who in personal calls to BHP chairman Jac Nasser and other convinced the big miners that she was genuine about settling the dispute, and resources minister Martin Ferguson, who Gillard inserted into the process after her appointment as PM.

And it is one that has been achieved at a manageable cost to the budget. The tax take in the first two years to 2013-14 falls by $1.5 billion to $10.5 billion, as the government loads in higher commodity price assumptions that are closer to what is actually being achieved this year, cuts its linked cut in corporate tax by one percentage point to 29 per cent, and axes its poorly received exploration tax rebate.

The deal seems to cover all the bases. It satisfies Gillard’s only condition, that the government’s tax take from the resources boom rise. And it exempts most mines from a new tax, while charging those captured by the regime less than the 50 per cent plus total tax rate they faced under the Rudd version.

The iron ore and coal miners will pay corporate tax after the resources tax has been paid, and when coal and iron prices are high as they now, will face a total tax bill of more than 40 per cent, with a maximum above 45 per cent, according to one person close to the negotiations.

There’s a way to go. The Greens have been making ominous noises about blocking a compromise, for example. But Gillard’s backflip is politically marketable – and an election campaign must surely now be just around the corner.

Paul Keating has challenged a central tenet of Kevin Rudd’s multibillion-dollar, 20-year military blueprint, warning the Government has taken too defensive a stance in response to China’s rise in the Asia-Pacific region.

Returning to his “big picture” theme of Australia’s place in the world, the former Labor prime minister said last night the effects of the global financial crisis had matched the radical transformation of global affairs following the Cold War.

“I think we can safely say that the pendulum point of world economic activity has shifted and settled upon East Asia,” Mr Keating told a Perth audience.

The US – having in the past seven years gone from the world’s largest creditor country to largest debtor – was beset by uncertainty, he said – “Its financial mendicancy, its economic structure and its social and demographic problems.”

He said the US must turn away “from the mindless fizz of ever more consumption” and bring back to life manufacturing in American cities.

Mr Keating acknowledged the countries in East Asia confronted profound strategic problems – whether China’s one-party political system could maintain economic growth, for example, how Japan would cope with a rapidly ageing population and the prospect of unification on the Korean peninsula.

But China might eventually eclipse US power in the region and the major shifts in world power offered huge opportunities for Australia.

“With all that has happened and is happening, it will make absolutely no sense for us to think of our security in isolationist and defensive terms,” Mr Keating said. “The notion of Australia’s security being found outside Asia is as absurd now as it has always been . . .”

He said Australia’s international outlook must always remain outgoing and positive.

“For these reasons, I found myself at odds with some of the text of the Government’s 2009 defence white paper,” he said.

“Much of it is unexceptional . . . but it goes on to discuss what it describes as ‘the remote but plausible potential of confrontation’ between us and ‘a major power adversary’, not suggesting who that power might be.

“Obviously, it will not be the United States. You are then left to take your pick of China, Japan, India or Indonesia.”

Mr Keating said the tone of the paper was too ambivalent and failed to state clearly whether China’s military advance posed a threat to Australia or was a natural and legitimate aspiration for a rising economic power.

Released in May, the paper pledged a doubling of Australia’s submarine fleet from six to 12, extra warships, cruise missiles and advanced jets.

The paper took a swipe at Beijing for a lack of transparency in its own military build-up and warned that “shows of force by rising powers are likely to become more common as their military capabilities expand”.

Delivering the annual John Curtin Prime Ministerial Lecture, Mr Keating said Australia could not predict what sort of new order might spring up in the face of relative American decline.

“A region of this kind might turn out to be as peaceful and as prosperous for Australia as the one we have had since the end of the Vietnam War,” he said.

Accepting the need for defence readiness, he warned: “Too often, Australia has created problems for itself when its defence policy has gotten ahead of its foreign policy. Vietnam and Iraq are prime examples.”

He praised China’s huge economic leap forward in recent decades – “This great state, with its profound sense of self and the wherewithal to make a better life for its citizens, has eased itself into a major role” – a development, he said, that would be altogether positive for the region and the world at large.

“We do know China will be a power in its own right and a big player,” Mr Keating said.

THE decades-old benchmark system for setting the price of iron ore looks to be on its last legs with no agreement expected by last night’s deadline between major producers and Chinese steel mills, as reported in the Herald yesterday.

Rio Tinto and BHP Billiton had until midnight last night to reach an agreement or risk moving to volatile spot prices for its customers.

It would be the first time in the 42-year history of the benchmark system that no agreement has been reached by July 1.

“I think there is definitely going to be a move away from the benchmark towards spot pricing and index pricing,” said a Fat Prophets mining analyst, Gavin Wendt.

The move may play into the hands of BHP Billiton, which has said the benchmark system should go.

Rio Tinto confirmed that some contracts may revert to spot market pricing today as China’s steelmakers argue for a deeper cut than its Asian rivals agreed.

A Rio spokesman, Gervase Greene, said talks were continuing: “Rio has long been a supporter of the benchmark system but if customers choose to buy on the spot market instead they will.”

China overtook Japan as the biggest buyer of iron ore in 2003. Until then, benchmark prices had usually been set by Japanese or European steel makers.

Although other Asian steel makers have accepted new benchmark prices, mills in the world’s largest iron ore market – China – have held out for a better deal.

Benchmark agreements settled by Rio Tinto included a 33 per cent cut to last year’s prices. The Chinese mills are insisting on reductions of 40 to 45 per cent.

Mr Wendt said the Chinese risked being left short of supply unless they signed a deal, especially if demand picked up in Europe.

“It is a high-risk strategy for sure. They are trying to play this game of brinkmanship,” Mr Wendt said. “They are trying to stare down Rio, and Rio isn’t blinking.”

The Brazilian producer Vale has been waiting for Australian miners to settle contract prices before concluding its own agreements. It has agreed to cut prices by 28 per cent for ArcelorMittal.

A SWEETENED offer of $US1.38 billion ($A1.69 billion) for the bulk of OZ Mineral’s assets has won the day for China’s state-owned Minmetals.

Battle-weary OZ shareholders roundly endorsed the deal at a meeting in Melbourne (92 per cent approval) but not before hurling abuse at the OZ board for what they saw as its role in making the former high-flying miner a major casualty of the global financial crisis.

A big protest vote on the re-election of long-standing director Michael Eager was also recorded (42 per cent against) and the adoption of OZ’s remuneration report was defeated (62 per cent against).

All of that reflected what OZ chairman Barry Cusack said had been an “extremely stressful time” for OZ since the financial crisis hit in mid-September, prompting OZ’s banking syndicate to call in $1.1 billion in debt.

Minmetals project director Mark Liu said after the meeting that the group’s decision to increase the offer demonstrated “goodwill, not only to OZ shareholders but to the Australian public as well”. It comes as the uproar in China continues over Rio Tinto’s spurning of a refinancing deal with state-owned Chinalco.

Minmetals’ original deal was struck in February. Like the Rio Tinto deal before it, it was essentially a refinancing package for the debt-heavy OZ. But it had become unpalatable because of the strong improvement in commodity prices and equity values since.

Last Friday, OZ received two refinancing alternatives, one from RFC and Royal Bank of Canada and one from Macquarie. Both were rejected ahead of yesterday’s shareholder meeting because they lacked, among other things, the certainty OZ was looking for as its June 30 debt repayment deadline loomed.

It was revealed yesterday that Minmetals had been in talks with OZ for about three weeks on increasing its offer to take account of the improved market conditions. The improved deal was agreed to at 8pm on Wednesday night and announced by Minmetals at 10pm, leaving OZ to tell shareholders of the improved offer at the meeting.

OZ said that unlike the competing proposals (Macquarie pulled its bid at 6pm on Wednesday), the new deal with Minmetals was a complete solution to its debt woes.

The only condition was that shareholders approve the deal at yesterday’s meeting.

OZ emerges from the deal sporting close to $800 million in cash and with its portfolio of interests reduced to some exploration assets and the Prominent Hill copper/gold mine in South Australia.

Mr Cusack said OZ would be cautious in how it spent its cash. “Having just come out of a life-threatening experience, we want to make sure that we don’t fall back into one,” he told shareholders.

ELIZABETH KNIGHT
June 11, 2009 – 11:57AM
The Chinese cannot be accused of being slow to learn their lessons.

Minmetals would have watched very closely the unfolding disaster that fellow Chinese-owned Chinalco suffered last week at the hands of the board of Rio Tinto.

Chinalco had a once in a lifetime opportunity to get its hands on some unparalleled resource assets in Australia.

It was in the box seat to double its stake in Rio Tinto and take direct stakes in highly sought after assets but it blew it. It got greedy.

Had it delivered a drop dead price on day one the outcome could have been very different.

Minmetals last night and at the 11th hour increased its offer for the OZ Minerals assets it is able to buy, by 15 per cent to $US1.386 billion ($1.75 billion).

The sale of these assets has been one of the most contested deals in recent corporate history.

Macquarie Bank was the primary rival to Minmetals – the Australian bank’s plan involved a recapitalisation for which it would receive some hefty underwriting fees.

But in the end Macquarie’s deal was too risky – given that it would need to provide bridging finance until an issue had been undertaken.

Only a very brave – or foolhardy – organisation would extend finance to an overgeared company like Oz Minerals whose existing bankers are already holding a gun to its head.

Going into this morning’s OZ Mineral shareholder meeting to approve the Minmetals the board made it clear that the banks had cocked the trigger and were ready to squeeze in the event that investors voted against the sale of assets to Minmetals.

It could be argued that on this basis – and given the proxies received indicated that it would be approved – that Minmetals didn’t need to raise the offer.

But there is nothing like certainty – even if it comes at a price.

Lobbing a better offer – and one that sits inside the independent experts range of values – is probably cheap insurance.

Barry FitzGerald
June 11, 2009
OZ MINERALS will proceed with a shareholder vote today on its controversial $1.5 billion refinancing deal with China’s Minmetals after a last-minute $1.4 billion alternative proposed by Macquarie Group last night fell over in embarrassing fashion.

Macquarie told OZ it could not deliver the “degree of certainty” its board would have required to support the proposal. It is believed that Macquarie was unable to secure sub-underwriting support from a market yet to be fully convinced that recent commodity price strength will stick.

OZ said that without the necessary guarantees in the Macquarie proposal, it would have been faced with the same dire consequences it would have faced if the Minmetals deal had collapsed – the prospect of its banking syndicate forcing a move into administration.

But OZ’s chairman, Barry Cusack, faces a tough assignment in herding shareholders towards the Minmetals vote. This is likely to prompt a heated debate at today’s meeting in Melbourne on OZ’s dismissal of Macquarie’s initial alternative proposal, and a $1.5 billion recapitalisation proposal put forward by the RFC Group and the Royal Bank of Canada.

OZ said earlier this week it was convinced the Minmetals deal remained the best solution to its debt woes following a “scrupulous” assessment of competing recapitalisation plans. The deal involves OZ selling all its assets to Minmetals with the exception of its new Prominent Hill copper and gold mine in South Australia.

OZ said that while the board considered Macquarie’s original equity recapitalisation proposal to be better than the RFC-RBC proposal, neither was superior to the Minmetals deal.

Like Rio Tinto’s now aborted $US19.5 billion refinancing deal with China’s Chinalco, the OZ deal with Minmetals was struck in February when the cloud over commodity prices from the global economic crisis was at its darkest.

Commodity prices have since rebounded, convincing Rio to refinance itself through a heavily discounted rights issue and an iron ore joint venture in the Pilbara with BHP Billiton.

But OZ’s refinancing needs have been more pressing than Rio’s, with the company raising the prospect of having to go into administration if it could not deal with the $1.1 billion debt repayment demands of its banking syndicate.

An early deadline was recently extended to June 30 to allow time for the Minmetals deal to happen.

An independent expert has previously valued the assets to be sold to Minmetals at up to $2 billion, $500 million more than on offer from Minmetals. But the expert said that the deal was in the best interests of shareholders. OZ shares closed down 2c at 89c yesterday.

“As a result of our previous bid for Rio, there are a number of conditions that I can point at and those obviously still remain.”

Mr Kloppers pointed to the more than $US10 billion savings the two companies say they seek from the WA joint venture, which “were such an important part of our original desire to put these two companies together”.

BHP Billiton’s hostile bid for Rio fell through last year amid concerns over Rio’s debt burden resulting from its 2007 acquisition of Canadian aluminium giant Alcan.

BHP Billiton cannot make a fresh bid for Rio until November 25 this year – 12 months after its last bid collapsed – under the UK’s Takeover Code rules.

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Dave of Perth Reports from the UK in February said top institutional investors had urged BHP Billiton to relaunch a takeover bid for Rio Tinto to scupper its now abandoned deal with Chinalco.

Chinalco-Rio Tinto deal dead

Overnight, Rio Tinto walked away from what would have been the biggest deal in Australian corporate history, its $US19.5 billion ($24.4 billion) alliance with Chinalco.

Rio Tinto chairman Jan du Plessis said in a letter to shareholders the planned deal with Chinalco was now dead and his company would pay it a $US195 million ($243.2 million) break fee.

“The transaction announced and recommended by the boards will now no longer be pursued,” Mr du Plessis said.

In a statement, Chinalco president Xiong Weiping said he regretted the deal was off.

“In recent weeks Chinalco has worked hard to respond constructively and engage with Rio Tinto to make appropriate amendments to the transaction terms … to better reflect the changed market background and feedback from shareholders and regulators.

Rights offer

Rio Tinto, saddled with about $US38.7 billion in debt, had been pursuing a tie-up with Chinalco.

With the deal off, Rio Tinto will seek to raise $US15.2 billion in a rights issue, which shareholders in Rio Tinto and its London-based Rio Tinto Plc can take part in.

Shareholders will be offered 21 new shares for every 40 shares held at $28.29 or 1400 pence each.

Rivals to team up

With the Chinalco deal off, BHP Billiton and Rio Tinto announced a 50/50 joint venture, combining all their iron ore assets in Western Australia. It is expected to save them $US10 billion.

The joint venture deal is likely to annoy Chinese steel producers, which have long believed the big Australian iron ore producers hold too much power to decide iron ore prices.

BHP Billiton is the world’s biggest mining company and Rio Tinto is the third largest.

“I am delighted that we are able to announce a transaction that can deliver significant real and quantifiable synergies to our shareholders,” BHP Billiton chairman Don Argus said.

By midday, BHP soared $2.83, or 8.06 per cent, to $37.94, while Rio advanced $6.60, or 9.87 per cent, to $73.50.

BHP Billiton predicts the global economic recovery will be slow and protracted, but says there’s reason for some cautious optimism in China.

Chief executive Marius Kloppers told a minerals conference in Canberra that it would be another six months before there were clear signs of the true situation for the company’s markets in China and the OECD.

“The best we can say in the medium term is that conditions remain uncertain,” he said.

In the US, there was still a downside risk with unemployment remaining a problem. The economies of Europe, especially the UK and Germany, were still a worry, and Japan was weak.

On China, Mr Kloppers said there were a few reasons for optimism including early signs about growth, Chinese loan activity and in the construction and real estate sectors.

“If all of these trends continue in the second quarter they will give us some reason to be cautiously optimistic,” he said.

But Mr Kloppers stressed the need for caution because there were still issues around Chinese exports, adding the company did not expect in the medium term a sharp return to overall economic activity.

“We probably believe as a company the economic recovery will be both slow and protracted,” he said.

A SURPRISE surge in Chinese demand for high-quality coal used in steel making has raised hopes that Asia’s growth engine could offset the slump engulfing Australia’s biggest export.

Queensland’s coal terminals at Hay Point and Dalrymple Bay last month posted their strongest results since November, shipping 7.2 million tonnes from the region’s coking coal mines.

Producers say the turnaround was driven by heavy Chinese buying on the spot market – in stark contrast to the country’s traditional role as a net coal exporter.

After slashing production when recession hit last year, miners are meeting the extra demand by running down stockpiles. If the surge continues, it could help revitalise demand for the type of coal that fetched $US300 a tonne last year, compared with about $US125 ($161) a tonne in recent contract negotiations.

The chief executive of Felix Resources, Brian Flannery, said after making one shipment to China in four years, the company was likely to sell 10 shipments this year, possibly more. “We’ve had a cutback in the Japanese off-take, which has probably been picked up by our Chinese off-take,” he said.

The executive general manager of corporate development at Macarthur Coal, Ian McAleese, said the Chinese buying had prompted “quite a significant turnaround” in demand but the longevity of the surge remained uncertain. “Because they historically have not been in this market, it’s very difficult to get a read,” he said.

Producers say it has suddenly become cheaper for Chinese companies to buy coal from Australia because of difficulties setting domestic prices. China’s Government has closed several mines because of safety concerns, further limiting supply.

A spokeswoman for the world’s biggest private coal producer, US-based Peabody Energy, said the extra demand was equivalent to 10 million tonnes a year of coal being sent to China. Although it had not offset the global slump in world production, she said the company was confident the market was picking up.

While the trend is promising for the industry, coal is unlikely to test the record contract prices of last year while the world’s biggest buyer – Japan – remains in recession.

An analyst at Patersons, Andrew Harrington, said demand growth in India and China was the most likely reason behind any improvement in the coking coal market in the next six months.

But hopes of a fast recovery were hit last week by news that Japan was shrinking by 15.7 per cent a year, the fastest rate of decline since the Second World War. “There will be too much uncertainty, even in the first quarter of next year, to be confident of a price increase,” he said.